After reading my 641^st article confidently explaining ‘what Trump’s election victory means for markets’; I was reassured that there seemed to be a broad consensus on its implications. This allowed me to invoke one of Bob Farrell’s ten investing rules: “When all the experts and forecasts agree – something else is going to happen”. While the clarity provided by the election result may have provided some relief, it should not embolden us into believing we know what will occur next, because the truth is that we have no idea.

No matter how uncertain the outcome of a particular event is, what we know with absolute certainty is that when the results are in we will discuss them as if they were an inevitability. And so it is with the US election, where in reading the post-mortems of Trump’s victory we are led to wonder why the Democrats contended the election at all given how obvious its conclusion was.

From an investment perspective it is, however, critical to remember that the result was – for many – considered to be the flip of a coin with very few people willing to take a high conviction view on who the victor would be. This is important because it brings into sharp contrast an odd dynamic whereby most market participants were (rightly) unwilling to predict the outcome of a one-shot, binary election result around which there was a huge amount of data and information, but are now comfortable telling us what the longer term market and economic consequences of it will be. If we can’t answer the easier question with confidence, let’s not try answering the harder one that is immeasurably more complex.

Another favourite investor activity following an event such an election is to look at the immediate financial market reaction, hoping it will provide us with a sure guide as to what lies ahead in the coming months and years. It would be fantastic if this were the case, but it isn’t. When it became clear that Trump would regain the Presidency were investors hastily updating their inflation assumptions and quickly reworking their equity DCF models, or simply trading based on how they expected other investors to trade? Almost certainly the latter.

Market activity around such periods is both self-referential and self-reinforcing. Market participants decide how they will react prior to the event (in the most recent case the so-called ‘Trump trade’) and then react in that way immediately after. It doesn’t provide us with any longer-term fundamental insights, as much as we might want it to.

As markets were busy digesting the results of the 2024 election I looked back at the initial reaction to Trump’s 2016 win. In the two weeks that followed, the ten-year treasury yield rose, as did the dollar index, while in US equity markets financials, industrials and energy outperformed the wider market. And what happened over the full four-year term? Treasury yields fell, the dollar index weakened and all three of the aforementioned equity sectors underperformed the index.  

If the market was really telling us something immediately after that election, why was it wrong?

There are four critical reasons that make taking confident views about election results is so dangerous for investors:

– We don’t know what they will do: Although we can surmise and hypothesise, we have no certainty around what decisions a new administration might make.

– We don’t know what the consequences will be: Even if we did know what decisions would be taken, trying to understand the financial market consequences is close to impossible given its sheer complexity and deeply interwoven nature.

– We don’t know how much it will matter: Even if we knew what a new government would do and had some idea of the broader implications, it is still difficult to judge how to weight it relative to other factors. Is the occupant of the White House more important to equity market performance than how AI / tech develops from here? There are many, many variables that will matter and some will almost certainly be more consequential.  

– Other stuff will happen: Perhaps the most essential challenge for investors is that perennially frustrating problem of other things happening, things that we are not even considering today. These are likely to overwhelm whatever we are thinking about right now.  

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Investors abhor uncertainty and we are always looking for clues to how the future will unfold. Unfortunately, unpredictability is an ingrained feature of financial markets, not something that can be solved, and it is dangerous to believe it can be. More often than not admitting that we don’t know is the right answer and the one likely to lead to better investment outcomes over the long-run.   

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US). 

The week of the US election is the perfect environment for investors to make unfathomably difficult forecasts about financial markets with entirely unjustifiable levels of confidence. These could be about anything from identifying which equity market sectors might benefit from a particular outcome to forewarning a rout in US treasuries. Making decisions based on such prognostications is a wretched idea. This is not just because of the difficulty inherent in any given prediction, but because for it to be worthwhile investors have to keep getting such calls correct over and over again. The chances of this are slim and the downside severe.

When considering the type of investment decisions we want to make we need to ask ourselves not only about the likelihood of being right about a specific circumstance, but of being consistently more right than wrong in similar situations through time.

This is the challenge that resides at the heart of making bold macro calls or attempting to aggressively time financial market movements. While we might be fortunate with a view in a certain instance – how likely is it that we will overcome the odds and keep doing it?

No investment decision is ever made in isolation. We always have to consider: what comes next? Let’s imagine that we forecast a recession and an equity bear market – even if we are right, will we continue to be so? How deep will the downturn be? When will it end? What will the recovery be like? Each situation has its own unique set of complexities and uncertainties, which means that even if we strike it lucky once, we must repeatedly answer incredibly difficult questions. It is never one and done.

It is not even sufficient to be more right than wrong. We also need to understand the cost of being wrong, and our ability to recover from it. One mistaken call on an equity market downturn or a surge in inflation could prove irrecoverable. Investors making regular high consequence, high complexity decisions are playing Russian roulette.

This is exactly what we frequently experience with prominent hedge funds managers. They are given the limelight and earn astronomical performance fees (no clawbacks) for getting one big decision right. The problems then arise when they have to repeat the trick.  

If we are to consistently engage in low probability investment activities then we will either fail quickly or slowly. Slowly – if we are circumspect then over time the poor odds of what we are doing will catch-up with us. Quickly – if we take enough high consequence bets then one of them will end in disaster.

The interminable noise of weeks such as these gives entirely the wrong impression of what investing is and should be about for most people. Getting macro and market calls right is hard once, doing it repeatedly is close to impossible. Fortunately most of us don’t even need to try.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

Which modern US presidential election has had the most significant impact on long-run asset class returns? I have no clue, but I am going to confidently tell you how financial markets will react to the upcoming one. Major events matter a great deal to investors even though history tells us that it is impossibly difficult to foresee their consequences, or indeed know whether they will matter at all over the long-term.

Ignorance would be bliss

The most obvious reason that noteworthy events, like presidential elections, are so diverting is that they are inescapable. We cannot help but have our attention drawn to them, and we consistently overweight the significance of things that are salient and available – that which is happening right in front of our eyes. To make matters more difficult, events like elections can have great importance in certain aspects of our lives, but not have much bearing on the long-term success of our investments. It is incredibly difficult to disentangle this – when an issue is relevant, we cannot help but think it is relevant everywhere and to everything.

It is also almost impossible for an investor to remain indifferent to a topic over which the asset management industry is obsessing. The fact that everyone has a forthright opinion on a subject bestows a significance upon it. We can join the party, or risk appearing negligent.

The threat of being labelled as inattentive to a profoundly consequential occurrence is exacerbated by the fact that – over the short-term – events like presidential elections will have an impact on financial markets. Many investors are involved in playing a game of predicting how other investors will react to a certain development: If x wins the election, then y sector will benefit – this type of behaviour is self-perpetuating. Markets move on events because investors expect markets to move on events. Although engaging in such speculative activity is unlikely to be beneficial, it does make doing nothing challenging – “you said elections were irrelevant, but look how markets have reacted”.

During such times it is easy to do things that are positive for how we are perceived, but negative for what we are trying to achieve.

Even if we are resolute enough to ignore the noisy, near-term ramifications of high-profile market events, surely they sometimes have longer-term consequences? It is possible, but requires us to predict profound structural changes in financial markets or economic conditions. It is far from easy to link an isolated past event to subsequent market performance – believing that we can do it for the future seems fanciful.

Complex problems

When we consider major events it is inevitably in a deterministic fashion. We believe that an event will precipitate a specific reaction, but that is not how complex systems work. They are chaotic and unpredictable. The result of one binary event (such as an election) could set us off on a million different paths, based on the disordered interactions of an incalculable number of variables. A deterministic approach makes us feel comfortable amidst substantial uncertainty, but it is in no way a reflection of reality. Investors might want it to be one way, but it is the other.

The best evidence of the challenge of making predictions around the financial market implications of events is how little time is spent reflecting on our previous forecasts. When a pundit spells out the consequences of the coming election result, how often do they inform us of their prior prescience around historic elections? On average, never. This is not just because they were probably wrong and that might inhibit our confidence in them, but because when we look back we will see quite how messy everything that followed was and how difficult it is to draw clear lines of causality. The US election is unlikely to be an epochal event that fundamentally changes the long-term financial market outlook (certainly not in a predictable way).

A common approach to simplifying the logic around how financial markets might behave around an election is to look at past instances of the same event. The problem of this – particularly when they are relatively rare – is that the sample size is inescapably miniscule, and each instance is influenced by a specific set of variables that were relevant only at that time. Confidently drawing inferences from such analysis is fraught with danger.     

Managing event risk

If engaging in speculation and prediction around the US election is unlikely to be prudent, what should investors do – just ignore it? Yes and no. Most investors with sensibly diversified portfolios haven’t really ignored this event or any others, they have instead used the principles of diversification when building their portfolios to reflect the fact that the future is inherently uncertain (and that includes event risk). A well-diversified portfolio is one which is robust to a range of different outcomes in financial markets – sufficiently resilient in the short-term to meet long-term goals. Unless we have a high conviction that the election materially changes the risk and return characteristics of key asset classes, our best approach is to do nothing and stay diversified.

When event risk is on the horizon, investors often gain comfort from running stress tests and scenario analysis on their portfolios, this can be problematic. As the saying (sort of) goes: all models are wrong, some are also useless. While it can – if framed with the appropriate context and caveats – be very helpful to understand the potential range of outcomes faced by a portfolio; tests that attempt to specify how asset classes will behave following a particular event are inevitably founded upon unrealistic and overconfident assumptions about the future. They can give us a false sense of certainty and should be handled with the utmost scepticism.

A stress test that would be beneficial for investors would be one that warns us of the type of poor decisions we are liable to make when under stress. These are the stresses that will have a predictable impact on portfolio outcomes.

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Significant events such as the US election present an acute challenge for investors. Sticking to our plans and admitting the limits to our knowledge amidst the maelstrom of pontification and prediction can seem almost impossible. Long-term, well-diversified investors should not despair, however, with a little fortitude it will pass away soon enough.

Until the next event.   

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

I recently came across a statement made by Warren Buffett in a 1965 letter to his Partnership where he mentioned group decision making: “My perhaps jaundiced view is that it is close to impossible for outstanding investment management to come from a group of any size with all parties really participating in decisions.” This made me reflect on the fact that the overwhelming majority of the literature and research around behaviour and decision making produced in recent decades has been about how individuals make choices, but in virtually every walk of life – politics, business, family and investing – decisions are frequently made by groups of people. Despite this little time appears to be spent seeking to understand how groups function. This is a severe oversight. If we thought individual choice was confusing and problematic, just wait until we start putting people together.

It is important to define what a group decision actually is. For me there are two key features:

1) People ostensibly working together to reach a decision.

2) More than one person has the ability to materially influence (implicitly or explicitly) the decision made.

A group decision does not have to be a situation where there are 11 people sitting on a committee and each holds a vote, in fact many collective decisions look like individual choices in that a single person makes the ultimate call, but are actually the outcome of group interaction and influence.

Why are most decisions made – in some form – by a group of people? There are two reasons. First is a desire to combine experience and expertise. In theory, better decisions should be made if there is an ability to access higher quality information and inputs. Second because there is a need to represent multiple stakeholders. Where a decision impacts different groups, there is often a requirement to provide an appropriate voice to those parties.  The makeup of most boards and committees should at least attempt to meet these two criteria.

While these both seem laudable aims, they can create profound decision-making problems if not handled considerately (and might still do even if they are). The investment management industry is overrun with implicit and explicit group decision making, but I have barely ever heard anyone talk coherently about how groups have been brought together. Yes, in recent years lip service has frequently been paid to the notion of cognitive diversity, but I have severe doubts that many people using the term have a clear idea of what it means and its implications.

Imagine involving a group of people in a decision all of whom have different personalities, incentives and beliefs, and expecting that to result in a coherent outcome. It seems entirely non-sensical, but this is exactly what occurs in most group decision making scenarios.

It is not that the construction of decision-making groups is random – there is generally some credible reason as to why people become involved in a decision – it is just that there is an inescapable complacency about how or why the interactions of the group will impact the type of choices being made. This almost inevitably leads to unintended consequences and undesirable outcomes.

There are several critical issues to consider when trying to avoid the major challenges of group decisions:

Goals and incentives:  The essential condition for effective group decision making is shared goals and aligned incentives. If the individuals with influence over a choice are not attempting to achieve the same objective then any decision it makes is likely to be greatly compromised. Organisations where group decisions take place are typically incredibly complacent about this, assuming that ‘of course’ all people involved have the same objectives. This is rarely the case, usually because the personal incentives of individuals are wildly misaligned.

The critical question to ask is – what is the primary incentive / aim of an individual involved in this decision? To take a heavily stylised example: Imagine there is a portfolio manager and a risk manager in a group involved in making an investment recommendation. The portfolio manager’s primary aim it to maximise return, the risk manager’s is to avoid disaster. These are both rational positions to take for them as individuals but it is very unlikely to lead to rational decisions at a group level – they have skin in different games. Now imagine it is not two people involved in an investment decision, but 17 all with somewhat contrasting motivations.

This is not to say that individuals with different specialisms and areas of focus cannot be involved in an effective group decision, it is just that for it to work they have to have their incentives aligned. Most groups involve a collection of people optimising for different things, resulting in sub-optimal results.

Philosophy and values: Consistent goals are integral to effective group decision making, but almost as important is shared philosophy and values. This does not mean that individuals within a collective have to think in the same way or attempt to tackle each problem in an identical fashion, but they must hold a set of common beliefs about the best way to reach their objectives. Group members can challenge each other without challenging their identity.

Decision making groups with a shared philosophy can discuss and debate the nuances of how best to apply that set of beliefs to the problem that they are trying to solve. Groups with philosophical differences will forever be trapped in unresolvable debates, often making little progress.

Accountability sinks: One of the primary risks of group decision making is the creation of what economist Dan Davies calls “accountability sinks”. This is where organisations remove individual accountability for decisions and instead place it into amorphous groups, policies and procedures. This creates a situation where nobody is to blame for anything – the system has responsibility. This can be quite attractive for people because being held to account is often unappealing, but it can lead to bad decisions, the complete removal of agency and chronic inflexibility.  The atrocious Horizon IT scandal that recently engulfed the British Post Office, is almost inevitably an extreme example of horrendous group / system-led decision making.  

Decisions can be categorised on a spectrum from those that feature individual accountability to those where there is no obvious accountability:

– Individual (Single accountability)
– Group (Shared accountability)
– Multiple Groups (Vague accountability)
– System (No accountability)

This is not to say that individual, sole responsibility decision making is always optimal, but we must be aware of the consequences of the shifting accountability structure that occurs as the number of people involved in a decision increases. Individual behaviour alters dramatically if we have 100% responsibility, compared to no ultimate responsibility.

Implicit group decisions: Another major accountability problem arises when decisions appear to have individual accountability but are actually heavily impacted or constrained by others. Similar to accountability sinks, this can be appealing for most group members because they can exert material influence without any consequence for their actions. It is not, however, appealing for the individual who is deemed to be the decision maker.  Davies, again, has a simple test for whether someone deserves to be accountable:  

“The fundamental law of accountability, the extent to which you are able to change a decision is precisely the extent to which you can be held accountability for it, and vice-versa”

It is quite common for individuals (or other groups) to hold the ability to materially alter a decision while seemingly being a great distance from any accountability for it. This typically occurs when people are able to apply constraints to a decision; here the accountable decision maker appears to have full responsibility for the ultimate course of action taken, but their set of options has already been greatly reduced by others.

This type of scenario often precedes the formation of accountability sinks – as when the accountable individual realises that they hold little agency they baulk at this arrangement, and prefer something more anonymous.

When assessing a group decision structure, it is vital to look at everyone with involvement and ask which individuals (or groups) have the power to significantly shape the ultimate choices being made.   

Accountability shields: A less common structure for a group decision is an accountability shield. In this situation, one dominant and influential party has an overwhelming power to dictate decision making. They are, however, reticent to bear responsibility for potentially negative outcomes and therefore create what appears like a group / committee / board structure to insulate them from full accountability. This creates an attractive asymmetry for the individual who holds power. The groups involved are functionally pointless, bar providing some protection in the event of disappointing results.

Groupthink: Although most of us never seriously consider the implications of group decision making, there is one topic that is always mentioned if the subject is raised – groupthink. This is a situation where a collective makes a poor decision because there is not enough challenge or critique from within the group. While this can be a valid concern, the issue is nuanced. Certain elements which may be classed as groupthink – such as shared ethos, values and principles – are an integral part of a cohesive group structure. It is, however, crucial that a broadly shared philosophy is allied with psychological safety, freedom of expression and a diverse set of skills. For harmonious groups to be effective they must be able to allow new ideas to permeate and accept that they can be wrong.

Groupthink is undoubtedly an issue worthy of serious consideration, but attempting to mitigate it by putting together a collection of ideologically opposed individuals with conflicting incentives is a bad idea.

The behavioural melting pot: Individual decision making is chaotic and idiosyncratic. Group decision making takes all of our personal foibles, puts them into a pot and stirs. It is impossible to understand how the choices made by groups will react to this confluence. As much as we might try to refine and reshape a group to improve its decision-making capabilities, a significant element will remain the wholly unpredictable noise that emerges from a convergence of personal behavioural biases.

Power dynamics: Power is perhaps only second to incentives in understanding what drives human behaviour. If we have a clear understanding of individual incentives and the power dynamic at play in any given situation, we can get a long way to understanding the choices that are likely to be made. Talking and thinking about how power impacts the workings of a group is unfortunately something few people are comfortable discussing, probably because we are reticent to upset the people that wield the power. In large organisations power doesn’t have to be held by individuals, it can be held by the system – a structure of policies, procedures and groups can wield an overwhelming but largely silent power.

Group size: When attention is given to group decision making, a common question pertains to the appropriate size of the group – what is the most effective number of participants? There is no right or simple answer here – it depends on the type of decision being made. One overlooked consideration is seeking to understand exactly how large a decision-making group is, which in many cases we probably don’t really know. Returning to my original criteria – we need to identify the people who both have input and can influence a decision. That is our real group size, which could be very different to the number of people sitting on a formal committee or board.

A large group size does have benefits as it should bring with it a greater diversity of skill and provide a voice to multiple stakeholders (where relevant). This notion only holds, however, if some deliberate thought is given to its construction. The main issue with sizeable groups is that most of the problems discussed in this piece become more likely and more pernicious the larger they get.

Group size and composition have a huge bearing on the type and quality of decisions made, but we pay barely any meaningful attention to them.

What defines a group that makes high quality decisions?

The sheer complexity of group decision making may make it seem like a problem that is not even worth confronting, but given how influential these dynamics are to most of the choices we make it is not something that we can continue to ignore. As always, the best way to deal with something that appears unfathomably complicated is to apply some simplicity to it. To my mind, there are three characteristics that a group needs to possess to have a chance of making smart choices:

1) Aligned goals and incentives:  A high-quality decision-making group must have shared goals – they have to be trying to achieve the same thing.  Companies tend to get this spectacularly wrong by creating vague purpose statements that will have no meaningful impact on anyone’s behaviour. Shared group goals are derived from shared individual incentives. Do good and bad outcomes look the same for each member of the group?

2) Shared philosophy and values: A consistent set of values held by the group members is essential for high quality decisions. This doesn’t mean that they need to agree on every aspect of a task or problem, but rather there are no major philosophical gaps between individuals. If there are then the group is likely to fall at the first hurdle. Shared principles should be the foundation of any effective group.  

3) Complementary skills: The key reason for having a group decide is that it grants input and influence to individuals with distinct and complementary skillsets. The more complex the task, the more useful this can be. The key challenge here is that people fall into what football fans might think of as the ‘Paris Saint-Germain trap’ (or maybe the English national team) where we believe that an effective group is simply a collection of the most ‘talented’ individuals. This approach almost always ends badly as it disregards the vital notion that a strong team combines different characters, skills and expertise to meet a particular goal. Haphazardly combining some good individual decision makers will not create an effective decision-making group.

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I often find myself frustrated at the lack of thought given to individual decision making, but this pales into comparison with the neglect of group decisions. The majority of the choices that we make (particularly in a professional context) are made by some form of collective, but we spend incredibly little time considering how groups function and the type of choices they are liable to make. It is undoubtedly a messy and intricate topic, but most of us don’t even try to get the basics right. Instead groups risk being blighted by murky accountability, misaligned incentives, opacity and compromise – not the ideal setup for sound decision making.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

What will the Fed do next? How will conflict in the Middle East impact the oil price? What does a new bout of stimulus mean for the Chinese Equity market? Is the US economy heading into a recession or reflation? Investors are trapped in a vortex of noise. We are compelled to engage with and react to a rotating cast of inescapably prominent and impossibly complex issues. This constant state of flux is the lifeblood of the investment industry but poison for clients. For most investors 99%, of what we see, hear and feel in financial markets is not just irrelevant to what we are trying to achieve, it actively makes it harder to make good decisions and attain our goals. Why is noise so ubiquitous and what can we do about it?

Critical to the success of any investor is the ability to cancel out the noise that surrounds us and focus on the elements that will have a material influence on our outcomes. Given the sheer complexity and chaos inherent in financial markets this can seem like an impossible task – how can we figure out what is significant?

There are two key criteria we can apply to help us identify harmful noise in financial markets (which is the vast majority of what we encounter). For any issue or event, we should ask two questions:

– Does it matter?

– Is it knowable?

Unless we can answer both in the affirmative, we can classify it as unhelpful noise.

Let’s take each in turn:

– Does it matter? Here we are seeking to understand whether the subject we are focusing on will actually matter to what we are trying to achieve. Let’s assume I have a 20-year investment horizon, will the next decision by the Fed have any obvious impact on my investment goals? Absolutely not. The same can be said for whatever geopolitical issue is the focus of our attention at any given point in time. If something is likely to have either no effect or a random influence on us meeting our investment objectives, then it is just noise. Spending time thinking about it is likely to leave us worse off. 

Even if something does matter – we are confident that some variable or topic will have a material impact on our investments over the time horizons that matter to us – it can still be noise, because it also must be knowable.

– Is it knowable? Being confident that something actually matters is a pretty high hurdle for investment information, but even that is not sufficient. For it not to be noise, it must be knowable or predictable. Why? Well, let’s say I was certain that the near-term decisions of the Fed or the latest geopolitical issue would have an impact on meeting my investment objectives – this is only meaningful if I know or can predict the outcome of these things. I need to know both that the Fed decision matters and believe that I can predict it, otherwise, what am I going to do about it?

If that isn’t tough enough, there is another problem. We often need to know two things – both what is going to happen and how it will impact financial markets. Many wonderful (lucky) predictions about a particular event have been rendered worthless because someone got the second part wrong. Forecasting any future occurrence is usually a herculean task, adding on a prediction of how it will then influence something else (alongside all the other unforeseeable things that might also impact it) is getting us pretty close to impossible.

So, how can we tell what matters and what is knowable? Well, we can apply some simple tests.

Does it matter?

Test: If I had a crystal ball and knew something would occur in advance, would it change my investment decision making?

This is a useful test for long-term investors because most things really should not influence our choices. There is a danger, however, of being overconfident and believing that certain pieces of information will move markets in an obvious way. Imagine having some foresight of 2020 ‘Covid’ economic data and making investment decisions based on that – it probably would have ended badly.

Is it knowable?

Test: Is the information already known or is there evidence that people can accurately predict it?

The most obvious piece of information that is in some way knowable is the valuation of an asset. For example, when bond yields were close to zero we didn’t need to make predictions about future returns being low – we knew this. Unfortunately, most financial market relevant activity isn’t knowable, it is instead reliant on making bold predictions about the future, which in complex adaptive systems is quite the ask.

Bringing these aspects together creates a simple framework for addressing the issue of noise in financial markets and the many problems it causes investors: 

Does it matter?	Is it knowable?	What to do about it?
Yes	Yes	Use the information
Yes	No	Diversify
No	No	Ignore

When people talk about current hot topics in financial markets – usually in wildly overconfident ways – we should be trying to apply this framework before anything else. Ask does the thing being discussed have any relevance based on my objectives and horizon, and if it does, is it reasonable to believe that it is in anyway knowable or predictable? The vast majority of things we can ignore, some things matter but are unpredictable so we diversify our portfolios, and a select few things really matter and should inform the investment decisions we make.

It is fair to say that what matters depends on the individual investor and what they are trying to achieve. So, for short-term traders many more events and occurrences will seem to matter because they are trying to judge near-term changes in sentiment. It is expected that they will interact with the market more than those with a longer horizon. The problem for investors taking such short-run perspectives is that most of the variables that might matter for them are not predictable in any reasonable or consistent way.

Using this framework leaves something of a puzzle, however. Most investors have long-term objectives, yet almost everyone seems to be obsessed with perpetuating short-term noise – constantly talking about things that don’t matter and / or are unknown and unpredictable. What causes such a dynamic? There are many, many factors at play, but here are a few ideas:

We want to reduce uncertainty: As humans we abhor uncertainty, and there are few things more uncertain than short-term financial market fluctuations. Engaging with what is happening and listening to people who confidently explain it (and predict how it will develop) is incredibly comforting. The sense of security it gives us is entirely false, but it feels real.   

We react to what is in front of us: Even if we try to avoid it, we are surrounded by news of what is unfolding right now and cannot help but think that what is happening in the moment is more important than anything else. 

We want to sound smart:  Talking about financial markets makes us sound smart. We can quite easily be wrong about how every major financial market event unfolds yet still sound credible and intelligent whilst doing it. The alternative is to say “I don’t know” or “it probably doesn’t matter” and that doesn’t do wonders for our conversations or career.

We don’t want to look negligent: One of the real challenges faced when trying not to engage with market noise, is that there will always be some events that will have an impact and matter (particularly in the short-run). We won’t know what these are beforehand, but after they occur everyone will act as if they were obvious and inevitable. We cannot risk looking negligent, so it is safer to treat everything as if it might be vital.

We avoid feedback: Does anybody genuinely keep track of the views they have on market events and short-term market moves? Almost certainly not. Everyone knows why this is, but it doesn’t matter because everyone carries on in the same fashion. ‘I was wrong yesterday and the day before that, but I will be right tomorrow.’

We focus on what matters to others: Unfortunately, it is not the things that matter to our long-term outcomes that are most important, but what other people think matters. If everyone else in the industry treats certain events or issues with the utmost significance, it is almost impossible to be an outlier. The industry acts as if these things are important, so clients think they are important, and it is rational to conform.

We want to sell something: Everything always in the end comes down to incentives. Noise, news flow and the conveyor belt of market events grease the wheels of almost everything that happens in the industry. It is in the interests of everyone to join in (apart from the clients).

We are bored: The willingness of investors to engage with market noise always reminds me of a social psychology experiment where participants were left alone in a room for fifteen minutes. They could either sit and think, or press a button that would give them an electric shock. 67% of men chose to electrocute themselves. Long-term investing is usually dull, embracing the noise of financial markets might be painful, but at least it stops us being bored.

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I often wonder whether the majority of people involved in the investment industry know that much of what is discussed and debated on a day-to-day basis is often irrelevant and almost always unpredictable, and just play along with the game, or if they actually believe that they stand apart from everyone else in their ability to make sense of the cacophony. Whatever the case, noise is a real problem for most investors and one that can lead to poor long-term outcomes unless we find ways to drown it out.

The next time you get drawn into a conversation about the latest market event try stopping yourself and first asking – does this matter and is it knowable? The answer will usually be no. 

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

One of the best moments of being a football (soccer) fan is when your team scores from long range. Although a goal built from an intricate passing move is undeniably pleasing, nothing quite beats a 25-yard rocket into the top corner. That’s why when a player finds themselves in space outside of the opposition penalty area the crowd will inevitably encourage an effort on goal with the dull roar of ‘shooot’. This is a mistake. The probability of scoring from distance is poor. It is typically a much better idea to try to work the ball closer to the goal. Shots from distance in football are like short-term investing – it feels right, but the odds of success are terrible. It is much better to do something else.

In his book on the use of data and analytics in football, Ian Graham (who played a major role in the success of Liverpool over recent years) highlighted work that showed while one-third of shots from inside the six-yard box are converted into goals, this falls to just 4% once outside the penalty area. There are several caveats to place around such numbers, but the general point holds –  shooting while being a considerable distance from goal is not usually a great decision.*

Why does this have anything to do with short-term investing? Well, trying to predict how markets might move over any brief time period (1 month, 1 year…) is another activity that we seem inescapably drawn towards despite it having little chance of success and being detrimental to what we are trying to achieve.

But why do we believe that long range shots and short-term investing are better ideas than they really are? Because of the influence of some of our most impactful behavioural foibles:

– We remember the wrong things: Our judgement of probability is inextricably linked to how available something is in our mind. Goals from long range shots don’t seem anywhere near as rare as they are because they are salient and we see them repeated continually, much more so than those that fail to hit the back of the net. Similarly, it is far easier to remember those short-term market calls that we got right, than the many we got wrong.

– We want a near-term fix: We prefer things that are exciting and give us a reward as soon as possible. Long range shots and short-term investing are far more stimulating than their alternatives, both of which require a great deal more patience and are just a little more dull.

– We want to be part of the crowd: Most people in a football crowd will urge the player to take the long shot, why would we not want to be part of this? Likewise, most people in the investment industry want us to engage with short-term market activity, so most of us do. Norms matter.

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There are situations where taking a long shot might be a prudent option. For example, a weaker team playing against a much stronger team my not get that close to their opponent’s goal so an effort from distance is their best chance. Yet even here the the similarities with investing are stark – speculation can only be justified when our objectives are speculative.

The further we are from goal when taking a shot the greater the uncertainty, the more other variables will get in the way and the lower the probability of success.   

The shorter our investing time horizon the greater the uncertainty, the more other variables will get in the way and the lower the probability of success.

Enjoying and encouraging a shot from long distance in football is entirely understandable and perhaps desirable. Football is entertainment – it is about moments and feelings – ignoring what the data tells us is fine, it might even make the game better. Most of us don’t invest for fun and, unless we do, we should avoid the long shot of being short-term.

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* These numbers are a simple representation of what the data tells us. There are a range of other factors that will impact the probability of scoring from various parts of the pitch, such as the relative strength of the teams involved, the player taking the shot, how easy it is to get the ball closer to the goal etc.. Such things are always noisy, but the point about long shots being overrated (from a data if not enjoyment perspective) still stands. There has been a reduction in long range shooting in high level football in recent years no doubt in part due to the increasing use of analytics.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

In the latest episode of Decision Nerds, Paul Richards and I talk with Professor Alex Edmans of London Business School. Alex recently published a book, ‘May Contain Lies’, which discusses our vulnerability to the misuse of evidence, statistics and stories, and how we can get better at deciphering the information that we consume.

Alex talks us through his ‘Ladder of Misinference’, which is a great framework for understanding how we might be mistaken when in receipt of information, and what we can do about it.

As part of the discussion we also cover areas including:

– How to help people move beyond black-and-white thinking and engage with complexity – getting the right mix of data and stories

– Why do bad ideas stick – do you still ‘Power Pose’?

– Changing minds – the power of good questions (there’s a great experiment on pianos and toilets that you can try at home).

– Trading off the short and long-term – why he chose the most critical agent to help him publish his book.

– Understanding neurological carrots and sticks – what happens when we put people in a brain scanner and give them statements they like and don’t?

– The state of debate around ESG and DEI – ideology, identity and pressures to conform.

I hope you enjoy the conversation, which covers a range of subjects that feel increasingly important.

You can listen to the episode in the usual places, or from the link below.

May Contain Lies

In his book on the concept of ergodicity, Luca Dellanna writes of his cousin who was a highly talented skier in his youth, but had a potential future in the sport cut short by a succession of injuries.[i] The lesson that Dellanna draws from this is that it is not the fastest skier that wins the race, but the quickest of those who reach the finish line. The risk of irreversible losses is integral to long-term success. Investors may think that maximising returns is their primary goal, but it isn’t. Survival comes first, and survival comes in several guises.

Diversifying Disaster

The most obvious case of the survival imperative is in the avoidance of catastrophic losses. These tend to stem from some form of concentration but are often complemented by leverage and complexity.  Although this might seem a simple risk to mitigate it is not, primarily because it is easy to be negligent about how susceptible to concentration we are. Just because a portfolio looks diversified – it holds lots of stocks, funds or asset classes – doesn’t mean it is.

Although diversification can be critical to survival, investors don’t really like it. When we diversify it says that we are uncertain about the future rather than confident, it also means that – after the fact – our portfolio has always performed worse than it might have done. Why didn’t we hold more of the asset that produced the strongest returns?

The danger of this is that we have only ‘line-item diversification’ – we hold a long list of names in the portfolio because it is deemed to be the prudent thing to do, but they are all exposed to very similar risks. When we do this we are prioritising return maximisation over survival, which is an incredibly dangerous approach.

Wrong on Average

One of the primary causes of survival neglect is looking at the wrong type of average. Investors can be susceptible to thinking about the average return of an asset class at a group level (XYZ hedge fund category has produced a 7.8% return over the past decade), but really we should care at least as much about the individual paths taken by the funds within that grouping (5% of the funds in XYZ hedge fund category lost more than 50%). The second piece of information feels more important than the first.

Humans can think in this way. When we buy home insurance, we (hopefully) don’t spend too much time considering the average loss experienced by all home insurance buyers (we know insurance companies should make a profit), we instead focus on the consequences of a bad outcome in our own personal experience.  Of course, as investors we cannot make decisions based on the worst possible result, but with any decision we make we must consider the potential adverse paths it might leads us down and whether we can survive them.

Salient Survivors

What investors really want is to identify investment strategies that survive and generate stellar returns. How do we go about finding these? Often by looking at individuals and teams that have achieved just that.

Although survivorship bias seems to be one of the most high-profile behavioural foibles that we encounter, this awareness doesn’t seem to provide much protection against it. High risk, highly fragile investment strategies – whether they be complex, leveraged hedge funds or concentrated equity portfolios – are constantly lauded when they produce extraordinary returns with rarely a mention of the many, many other similar strategies that were carrying similar risks but failed to survive.

Why is it so easy to fall into this trap? In part because of the salience of high-profile survivors – they become incredibly prominent and identifiable, far more so than the long, unmemorable list of those that no longer exist (notwithstanding the select group of notable failures) – but also because of our difficulty in accepting the consequences of high risk and good fortune. The successful survivors have inevitably enjoyed incredible luck, but it is our tendency to ascribe those outcomes to agency and skill rather than a dice roll.   

Surviving Ourselves

It is very easy to think about investment survival purely in terms of avoiding disastrous outcomes from the assets themselves, but although this is critical it is far from the only relevant aspect.  As important are the decisions we make through the life of an investment.

Any investment is only as good as our ability not to make bad choices while we own it.  

Poor decisions at the wrong time – selling at a market trough or following a prolonged spell of underperformance – is another survival problem. It doesn’t matter if the asset recovers from its difficulties if we have acted to crystallise the losses through our own actions.

The challenge is that it is incredibly tough to avoid such mistakes. When a fund is going through a poor spell of performance, we will desperately want to sell it and move on. And the longer the trend persists, the stronger the urge will become. The narratives will be overwhelming and the emotional toll heavy.

Every investor overestimates their aptitude for making smart decisions in the face of poor returns, yet every investment will go through spells of disappointing performance. Few of us seem prepared for this painful reality.   

To benefit from the power of compounding returns over the long-term, we need to survive the temptation to make poor decisions along the way.

Surviving our Environment

The lessons about the challenges of dealing with our own behaviour applies to private and professional investors alike, but for professional investors not only do they have to worry about themselves, they have to worry about their environment. This means not only considering their own behaviour, but also the decision making of their clients and their employer.  It is no good making a great investment decision if you might lose your assets or job before it comes to fruition.

Imagine you are a fund manager responsible for asset allocation decisions and happen upon a (functioning) crystal ball that means that you are sure that a particular asset class will generate the highest returns over the next decade. Would it make sense to own as much of the asset as you can within the parameters of the portfolio you are running? No, it wouldn’t, because the path will matter. You need to survive for the next ten years – what if the asset class that will win over the decade underperforms significantly for the next three years? Do you still have a job?

For a professional investor there is a requirement to make decisions where they can survive the weakest link in the chain. It might be their investments; it might be their own psychology, or it might be their environment.

For any investor to be successful there must be an alignment between their investment approach and the environment in which they make investment decisions. If there is conflict, the environment will win.

There is often a lot of cynicism about fund managers running ‘closet trackers’ or making decisions that seem to be designed for managing their own career risk. While such choices might not look compelling from an investment perspective, it is a rational activity for an individual looking to survive their environment.  

How to Survive

Long-term investing has many benefits, but to enjoy them we need to find a way of reaching the long-term. All investors need to think as much about surviving as they do about performance.  

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[i] Ergodicity, Luca Dellanna

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

Improving our investment behaviour is difficult. Our choices have a messy confluence of influences ranging from the explicit (financial incentives) to the implicit (our own psychological wiring). It is impossible to ever understand precisely why we made a particular decision – it is just too complex. This doesn’t mean, however, that we are helpless bystanders. In fact there are many seemingly innocuous areas that we can change to improve the chances that we might make sound judgements. Foremost of these is what we pay attention to – our investment decisions are inextricably linked to what we see and the impact it has on us.

A useful activity for any investor is to note down the major financial market issues that are in focus each week. After a year or so we can review these and realise how unworthy of our attention they were. As an added bonus, we might also want to make a prediction about how these issues will unfold so – on the rare occasion they are meaningful – we can see how lousy we were in forecasting them. This might seem glib, but it is not.  As investors, what we pay attention to dominates our decision making. We are bombarded with information (noise) that encourages costly choices at the expense of our long-term goals.

Our attention is drawn towards things that are available (easily accessible) and salient (provoke some form of emotional response). For investors this means whatever narrative thread is being weaved around random and unpredictable fluctuations in market prices. This is a major problem as the things we are being constantly exposed to are exactly the things that most of us should be ignoring.

For the majority of investors – those who invest over the long-term for profits, dividends and coupons – there is no need to have six screens providing a plethora of real time financial market information, knowing what equity markets did yesterday is an irrelevance and it is okay to ignore the latest hot topic. Even the areas that the industry treats as the most important thing in the world – such as what the Fed will do at its next meeting – just don’t matter that much to fundamentally driven investors with long-run horizons.

The asset management industry compels us to engage with all of these distractions, when the route to better decision making is finding ways to avoid them.

The problem, of course, is that avoiding them is incredibly difficult. Not only are we designed to care about what is happening right in front of our eyes, but everyone else behaves as if every move in markets is based on a vital new piece of information. Looking one way while the crowd looks in the opposite direction takes incredible resolve.

Is there anything we can do to stop us paying attention to the wrong things?

The first step is to separate the investment industry machine with its ‘9 seconds until markets open’ or ‘German equities were down 1.2% over the month after weak industrial production numbers’ from actual investing. In most cases, the incessant cacophony of financial market newsflow is nothing more than advertising – it is designed to grab our eyeballs, our clicks or our money in one form or another – it is an irrelevance to the real reason most of us are investing. Treat it for what it is – interesting but meaningless at best, a damaging distraction at worst.

Next, we need to clearly and explicitly define what we should be paying attention to. Based on our goals, what are the things that are worthy of our focus and attention? What are the aspects that really matter to meeting our objectives? These will be specific to each individual but will inevitably be stable and boring, and come with no requirement to care that the US ten year treasury yield fell by 7bps last week.

Asset managers – who are inevitably heavily complicit in this chronic attention challenge faced by investors  –  will say that financial markets are constantly in motion and that it is not feasible to simply act as if nothing is happening. Clients would be left uncertain, anxious and prone to even worse decisions. Although this sounds credible, it doesn’t really hold water. There is not a choice between adding to the gobbledegook or saying nothing at all. How about putting short-term financial market fluctuations in their appropriate context and explaining why it is rarely that worthy of our attention or action?

Talking about topics also bestows credibility to them. If asset managers spend time discussing monthly market fluctuations and performance, they shouldn’t be surprised if clients consider it to be important. Professional investors should always be asking themselves – how is what I am saying likely to influence the behaviour of my clients?

What we pay attention to tends to drive the decisions we make, and investors are persistently exposed to meaningless noise masquerading as meaningful information. We tend to perceive investment acumen in those individuals with an intimate knowledge of these daily market gyrations, but we have this entirely backwards – the ones with real skill are those who find ways to ignore it.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

Back in January 2022, I wrote the following about the fervour for ESG investing:

‘What happens when stocks and funds with positive ESG characteristics start to underperform? Investors are likely to move on to the next outperforming trend, particularly as we told them to focus on the performance prospects.‘

That this scenario has unfolded does, unfortunately, not reflect some remarkable prescience on my part; it is just the grimly inevitable denouement that occurs after a compelling story is combined with unsustainable performance and ferocious asset manager marketing to create wholly unrealistic investor expectations. When the industry has its next big idea, investor disappointment often follows.

This has nothing to do with ESG as a concept. There are plenty of positive and worthwhile elements attached to ESG investing, but unfortunately many of them were forgotten because of the zeal that came to define it. The question here is not about the validity of ESG, but rather why such cycles of investor obsession occur.

There are three important observations about big ideas in investing:

1) Past performance dominates investor behaviour: Past performance is the overwhelming force driving investor decision making – it consumes everything we do, whether it be a private investor or the committee of an endowment. We might not like to admit it, but our views and decisions are indelibly shaped by recent returns. No matter how committed we might be to an investment approach, style or asset class, two or three years of underwhelming returns will be more than enough to shake us out of it. Strong performance fuels the big idea as surely as weak performance kills it.

2) Substantial inflows erode future returns: One of the most perverse elements of investors ploughing assets into the next big idea is the apparent ignorance that the flows must almost certainly push valuations higher and future long-term returns lower. We are attracted to robust recent performance despite it dragging returns from the future into the past. The next big idea always comes with wholly illogical performance assumptions.

3) Asset managers will sell things that benefit them and sell them aggressively: If asset managers are fanning the flames of the latest big idea then there is a very high probability that it is better for them than it is for us. This is an issue that has been made more acute by the rise of index funds and compression in active fund volume and margins. Good businesses solve client problems, bad businesses try to solve their own. 

So, now that some of the froth that came to surround ESG investing has subsided, what’s the next big idea? It is difficult to be sure – something related to AI must be a strong contender – but perhaps private markets are the obvious candidate. The combination of high fees, long-term lock-ins, performance opacity and limited direct competition from passives makes them a perfect solution to many of the threats that asset managers are facing. It is unclear whether the benefits to clients are quite so significant.   

It is not that big ideas are necessarily bad ones. Many of the tenets of ESG continue to bring welcome attention to important and neglected areas, and it is by no means unreasonable for an investor to hold an allocation to private markets as part of a diversified portfolio. The problem is when these ideas are taken to extremes. They tend to become ubiquitous, impervious to challenge and saddled with wildly irrational expectations. To make matters worse, any genuine underlying benefits from the initial idea get lost amidst the excitement and inevitable comedown.

So, where does the rise of index fund investing sit in all of this? Is that another problematic big idea? No, it is not the same. The key difference being that it is an evolution that has largely been resisted rather than embraced (for obvious reasons). It has succeeded despite it being against the interests of the industry. That being said as investors we are always complacent about concepts that are performing well and underestimate how we will react if the environment changes. Index funds will not be immune to this behavioural reality and we should not be complacent about it. 

The simple truth is that the asset management industry needs big ideas more than investors do. All most of us need is small, simple ideas, consistently applied.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).